Did This Gold ETF Just Flash a Buy Signal?

Historically, the VanEck Vectors Gold Miners ETF (GDX) has outperformed in the weeks following 10% drops

Oct 5, 2016 at 11:57 AM
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The VanEck Vectors Gold Miners ETF (GDX) dropped roughly 10% yesterday, as gold suffered its worst day since 2013 -- a "signal" that's happened just twice since 2008. Amid the selloff, volume on the exchange-traded fund (ETF), as well as its options, hit an annual high. Traders were especially aggressive on the call side of the aisle -- much like they were with another gold ETF -- with International Securities Exchange (ISE) data confirming a 35,000-contract block of March 28 calls was bought to open, signaling bullish expectations over the next six months.

The question may be asked, though: Are these bullish expectations misplaced? To help us answer that question, Schaeffer's Quantitative Analyst Chris Prybal looked back to 2006 -- when GDX began trading -- to see how it's responded after similar drops of 10% or more. Here's what he found:

gdx after drops october 5

The short-term returns don't look so hot, with GDX averaging a loss of 2.9% and 2.2% three days and five days, respectively, after the signal. By comparison, the shares average modest anytime gains during those time frames. Going out 10 sessions and beyond, the ETF clearly outperforms. Forty days after a 10% GDX drop, the shares have swung 19.8% higher, on average, compared to an average anytime return of just 0.7%.

Having said that, things may be even better than they look at first blush. After all, most of the above returns happened in the midst of the 2008 financial crisis. The macro-economic environment is very different now -- notwithstanding the upcoming presidential election -- with the major stock market indexes not far from record levels.

If we narrow GDX's post-signal returns to the last five occurrences, the outperformance is even clearer. On average, after just 10 days, the ETF soared 19.2%. By 20 days, that average is up to 20.2%, with all five returns either flat or positive. Going out to 40 days, the typical post-signal gain reaches 31.1%.

Admittedly, the standard deviation after 10% VanEck Vectors Gold Miners ETF (GDX) drops is much higher than usual, so traders should be aware of potential volatility. However, the price swings after the last two signals -- that is, excluding the 2008 financial crisis -- were much more muted. In short, GDX's historical returns suggest some cautious optimism is very much in order.

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